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Wednesday, March 30, 2011

If you're an adherent of MMT like me, then you've probably gotten into arguments about debt and deficits with members of your family or maybe your friends or colleagues from work and I'm sure at some point in those discussions you've been asked the question, "How are we going to pay it back?" when it comes to government debt.

I have come up with a way to answer this question, which will at the very least, make the person you are arguing with sit up and think.

Here's a hypothetical conversation that you are having with a typical debt monger:

Debt monger: How are we going to pay it back?

You: The government exchanges dollars for those Treasuries. Holders of the debt give back their Treasuries to the gov't in exchange for dollars and Voila! no more debt.

Debt monger: You mean "print money" to pay off the debt?

You: That's precisely what I mean!

Debt monger: Are you serious?? That will create hyperinflation!

You: No it won't.

Debt monger: What?? Are you crazy??

You: Not at all. You are taking away one form of money--the Treasury--and simply replacing it with another form--US dollars.

Debt monger: But Treasuries are not money!

You: Oh really? If I had $10 million in cash and you had $10 million in Treasuries, would you consider yourself poorer than me?

We've been told by the neoliberal-Austrian-hard-money-fiscal-conservatism propaganda crowd that we must fear excessive government spending and debt because that will inevitably lead to skyrocketing and crushing interest rates. It's a "given" we're told, pretty much.

Yet once again a simple analysis of past history reveals the TRUTH--that there is no such correlation between government spending and deficits and interest rates. In fact, there is even weak correlation between inflation and interest rates as I will show. The only real thing that we can see, quite clearly in fact, is that long term interest rates are anchored by Fed policy and nothing more.

At this point those of you who are familiar with MMT and how the Fed uses monetary operations to set interest rates, please feel free to shout the phrase, "Duh!!!"

That's right...because long term interest rates are nothing more than the expectation of Fed policy over the term in question and if rates have been set lower for the past 30 years (despite exponentially rising gov't spending, deficits and even fluctuating inflation), long-term rates will trend lower.

Please examine the following charts:

Chart 1. Government spending vs Long-term interest rates

Absolutely zero correlation between government spending, which rose nearly 10-fold in the past 30 years, and long-term rates, which went down 73% over the period.

Chart 2. Surplus/Deficits vs Long-term interest rates

This chart is pretty clear: long-term rates have continued to come down despite a humongous surge in the deficit.

Chart 3. Inflation rates vs long-term interest rates

I would say the relationship between inflation and long-term rates, at least by looking at this chart, is suspect. Rates did drop sharply along with a concomitant decline in inflation from 1980 to 1986, however, inflation has since hovered in the 2% to 4% zone while long rates have continued to decline.

Chart 4. Fed funds vs long-term interest rates

We can quite clearly see a very strong correlation between the central bank's overnight interest rate target (Fed funds) and long-term yields. And why not? As stated before the long-term yield simply reflects Fed interest rate policy over the term.

"Over the long haul, the two series are close to equal, but when they diverge, they tell a story. The current story is that average consumers in the US are doing badly, while those benefiting from high corporate profits, and increasing exports are doing well."

It's the clearest and most accessible explanation of Krugman's opposition to MMT that I have encountered so far — and why it is wrong. It's a must-read.

"Governments in control of their money cannot be insolvent. Insolvency is the inability to pay off one’s debts as they fall due. That’s how Wikipedia defines insolvency.

"But the impossibility of insolvency does not mean the fiat currency will have value. A government might be fully solvent even with a worthless currency. On the other hand, Solvency and currency value do not imply each other.

"This distinction between insolvency and debasement is at the heart of MMT. MMT makes a huge distinction between the process of debasement and the act of insolvency – and this distinction has massive practical implications on how governments should act.

"First, it turns out solvency and currency value are confused, even by very smart people. Paul Krugman doesn’t understand this distinction...."

Whenever Quantitative Easing is mentioned in the media we hear a lot of commentary about “pumping money in” or “injecting liquidity.” Critics decry the money printing by the central bank, etc.

It’s all wrong.

I’m telling you this not that you’ll ever get into one of these discussions with your friends (you may) or even if you did, whether you’d be able to convince them of the fallacies of these arguments, but sometimes it’s just fun to know stuff.

A lesson in QE.

The term quantitative easing applies to a policy whereby the central bank, in this case the Fed, purchases assets (usually government securities) to expand the level of reserves in the banking system and, where desired, target a lower interest rate somewhere along the yield curve.

In the recent QE that was announced last summer, the Fed desired to bring down the interest rate on bonds and so it bought 5yr and 10yr Treasuries.

These Treasury purchases are done in the secondary market with the Fed buying from the public. The Fed doesn’t buy from the Treasury (it’s often misstated as that being the case). In fact, the Fed is precluded by statute from buying bonds directly from the Treasury.

When the Fed buys the bonds it “pays” by crediting the seller’s bank with reserves. Bond purchases (or any asset purchase) results in an addition of reserves to the banking system. Bond prices rise as a result of the Fed’s purchases and yields (which move inversely to bond prices) come down or, at least that’s the intent.

Is the Fed injecting “liquidity?”

No. There is no “liquidity” being injected anywhere.

That’s because all that’s occurred is an asset swap—a Treasury for a reserve balance. Both are exactly the same thing in that they are dollar denominated liabilities of the Federal Government, the only difference being their term and the interest rate they pay: Treasuries have some term, i.e. 2yr, 5yr, 10yr, etc while reserves are zero maturity. Both pay interest, but at different rates.

Therefore, when the Fed conducts QE, it strips the public of one asset—a Treasury—and replaces it with another—a reserve balance. No new money is created.

Is this hyperinflationary or even inflationary?

You can clearly see that it is not. It does not create any “new money” as, say, government spending would. All it does is change the shape of the yield curve, i.e. change the net duration of the financial assets held by the public.

Why did commodity prices run up, then? And why did the dollar tumble?

Perception, pure and simple. There is a belief that QE equates to the Fed “printing money.” Investors and traders act on that belief and push up the prices of commodities and they sell the dollar.

Why didn’t the Fed’s plan result in lower bond yields?

Part of the reason is because QE was widely perceived as being stimulative and a lot of economists started ratcheting up their economic growth forecasts. Bond yields rose on those forecasts.

Another reason why QE did not bring yields down is because the Fed decided to limit the program to a specific QUANTITY of bonds rather than target a specific rate itself. In other words, if the Fed wanted the 10yr to be at 2.0%, say, it should have stated that target and buy as many bonds as necessary to hit the target and then maintain it. This is how it sets the Fed funds target. Instead, the Fed said it would buy $600 bln, without knowing whether or not that would be sufficient to get to its desired rate.

(Now you know how to set rates, in case anyone asks you to run the Fed one day. ;))

What happens now that QE is ending?

Probably nothing.

Operationally, the Fed will stop buying bonds and crediting the banking system with reserves. Rates may move higher because the Fed will not be in there buying, however, to the extent that market participants feel “stimulus” is being removed, bond yields may actually come down. And since QE adds nothing to economic demand, the end of QE takes nothing away, either.

Furthermore, if investors feel that the removal of QE will result in less “inflationary pressure” from the central bank, commodities, gold and oil may come down and the dollar may go up. If so, all this will do is change the composition of the market’s leadership.

A dollar bill is a liability of the Federal Government. Just read what it says on that green piece of paper in your wallet: Federal Reserve “note.”

A Treasury is a liability of the Federal Government, too, but it pays some interest and has a term (2yrs, 5yrs, 10yrs, etc.).

Government can issue all the dollar bills it wants.

Government can issue all the Treasuries it wants.

Best way to think of it is the difference between a checking account and a savings account. Your net worth doesn’t change if you have your money in a checking account as opposed to having it in a savings account.

How do we pay off the debt?

The U.S. government can issue dollars to replace the Treasuries. It would be the equivalent of shifting the money from the savings account to the checking account.

Very simple.

So why are we having all this debate about the national debt and solvency?

"Paul Krugman added another post on the potential impact of large deficits on the U.S. economy in which he argues that it doesn't matter that the U.S. can print its own currency; it still faces the same constraints from financial markets. I would argue that it matters a great deal for two reasons that I laid out in my previous post.

"The first reason is that at any point in time the Fed would have the option to intervene in bond markets and buy up debt, if private investors were demanding very high interest rates. This is important because the decision by the Fed to not buy debt would always be a policy choice, not an economic fact."

Worse, Baker concludes:

"For these reasons it is important that the U.S. has its own currency. It can never be Greece. It may end up as Zimbabwe, but this sort of hyper-inflation would be the result of long period of badly failed policies in which our economy essentially unraveled. While that may not literally be impossible, even the biggest pessimists would have to acknowledge that we are very far from seeing this situation."

Krugman begins: "I think Dean Baker and I are converging on deficits and independent currencies. He asserts that having your own currency makes a big difference — you can still end up like Zimbabwe, but not like Greece right now. I’m fine with that."

Monday, March 28, 2011

Plan A is business as usual, based on competition and control. Plan B is meeting the enormous challenge that humanity faces through cooperation and coordination.

From Scott Thill's preface to the interview with Lester Brown:

"Japan's bungled response to a mounting nuclear crisis, thanks to one of Earth’s most destabilizing earthquakes and tsunamis, has in a cosmological eyeblink reset the entire world's nuclear ambition. Uprisings in hotspots like Egypt, Libya, Bahrain, Yemen, Saudi Arabia and more, compounded by America's continuing quagmires in Iraq and Afghanistan, are squarely knitting together civilization's crappy experiments like preemptive war, biofuels and light-speed financial stratagems into one titanic mess that is demanding new theories of cleanup.

"It's no longer intellectually feasible to consider any of these events as separate, because they, like the warming climate, are interconnected nightmares that are keeping us more awake than ever, whether we like it or not. And no matter how we spin them, Plan B argues, we're eventually all going to have to work together to survive what is without a doubt an existential crisis of historical proportions. Only the depth and vigor of our mutual efforts and understanding separate us and every other failed civilization in the planet's incomprehensibly expansive history."

How does this relate to MMT? An oft-heard objection to MMT is that it reinforces Plan A — business as usual — because the central objective of MMT is full employment along with price stablity, and fiscal policy — deficits to offset demand leakage to saving — is used as the primary tool to secure this objective. The objection is that as a consequence of liberal government funding, Schumpeter's creative destruction is forestalled, and malinvestment in coddled by what is effectively a government subsidy for failure.

This is patently not the case. It generally results from the incorrect assumption that the whole of MMT is the description of monetary operations. However, MMT is much more than that. Many MMT proponents take sustainability into account, Prof. Bill Mitchell being a notable example. Warren Mosler often says that our primary problems are institutional and he has put forward proposals for institutional reform.

Prof. Randy Wray has written a paper, Government Deficits, Liquidity Preference, and Schumpeterian Innovation, in which "Wray asserts that rigorous analyses of the role played by innovation in economic development must acknowledge the contribution of Joseph Schumpeter. However, the author suggests that the current stagnation confronting most developed, capitalist economies "cannot be understood without synthesizing Schumpeter's insights with those of Kalecki and Keynes." Hence, Schumpeter's work alone is inadequate in explaining the links between government deficits in ensuring aggregate demand and corporate profits."

Prof. Wray observes elsewhere that if we are going to solve our problems, we have to recognize that the limitations we face are never financial, but always real. It is always possible to finance solutions to real problems under the current monetary system, as long as real resources are available.

Humanity's primary real resource is humanity itself and the best investment is in human recourses. Futurist Ray Kurzweil has posited the law of accelerating returns, that is, technological innovation increases exponentially. MMT would add, as long as technological advance is not stifled by false notions concerning "affordability."

Moreover, a great deal of the excess leading to malinvestment is due to lax credit, which provokes financial instability, as Hyman Minksy showed. Minsky's work is central to MMT, and MMT proponents have put forward proposals for addressing institutional arrangements conducive to financial instability. See Warren Mosler's proposals, for example.

Predictably, Paul Krugman's unreferenced attack on "the modern monetary theory people — who say that deficits never matter, as long as you have your own currency" has drawn responses from some of the modern monetary theory people.

• Prof. James K. Galbraith responded in the comments to Krugman's second post. Mike Norman has posted Galbraith's comment:

There was a HUGE response by the entire MMT commuity to Paul Krugman's hatchet job that came out on his blog last week. (By the way, take note the very civil tone and all the highly thoughtful and intellectual comments posted all over the web by the MMT community. Compare that to the sick, ignorant and perverted filth that regularly spews from the likes of the Schiff crowd and the gold lunatics.) Please read the response of Jamie Galbraith, who literally embarrasses the Nobel Prize winner and leads him, like a child, in the direction he should be going.

What do you mean, exactly, by the phrase, “solvency of the government”?

According to my dictionary (Webster’s Third New International) an entity is “solvent” when it is “able… to pay all legal debts.”

If you will look in your wallet, you will find, on any Federal Reserve Note: “This Note is Legal Tender for All Debts Public and Private.”

Can we agree that the United States government, of which the Federal Reserve is a part, can always produce the Federal Reserve Notes required to pay its public debts?

It follows, without any possibility of misunderstanding or error, that the United States Government is always going to be solvent.

According to the same source, an entity is “insolvent” when it is unable to pay debts, or has “liabilities in excess of a reasonable market value of assets held.”

If this is what you have in mind, then please explain: what is the “reasonable market value of assets held” by the government of the United States? Go ahead, if you want, and add up all the land, buildings, aircraft carriers and submarines. And then, don’t forget to add the capacity to produce, without limit, pieces of paper of a legal – and therefore market – value of “one dollar” each.

Can this value, which is unlimited, ever be less than the finite value of public debts? No, it cannot.

Conclusion: A government that issues its own currency and owes its debt in that currency cannot be insolvent.

Now, let’s go to your hypothetical future case: full employment and a six percent of GDP deficit. Could this be inflationary? Sure. Could it cause a fall in the nominal exchange rate? Sure. Could the Fed offset this with higher interest rates, raising the rates paid on federal debt? Sure. And would the bonds sell? Of course they would. In an inflation, people don’t hold on to cash.

What can you mean, Paul, by your scenario in which “the US government [cannot] sell bonds on international markets”? All bond markets are international. Does it matter whether the buyers are “foreign” or “domestic”? Of course it doesn’t. It’s just as foolish to worry that foreigners might not buy our bonds, as it is to worry that they own too many of them now.

Can we agree, please, that this disposes of the non-issue of “solvency”? I hope so.

We’re getting over-run by waves of long-run deficit-hysteria and it does not help to complicate the question with this false issue.

Please turn your firepower to the very foolish statement just now by ten former CEA chairs, http://tinyurl.com/4ky3qpd not-including the admirable Joe Stiglitz. The ex-chairs claim, among other things, that the Bowles-Simpson report “documents that ‘the problem is real, and the solution will be painful.’” In fact, the B-S draft documents nothing at all; it has just one page of assertions and the rest is a laundry list.

In the course of a post at Benzinga.com, A Modest Proposal for Ending Debt Limit Gridlock: Feed the Children, Don't Eat Them, Prof. Randy Wray explains how the federal government creates money by crediting bank accounts as an introduction to his proposal for both simplifying the process and also resolving the dilemma of the debt limit. This is an excellent summary of the money creation process. I'm clipping it out and saving it for future reference.

The dilemma arises when the Congress appropriates funds for various projects and then finds that it has created a situation that prevents the US Treasury from issuing the funds to pay for what it has appropriated by exceeding the debt limit that it has set one itself. This is a self-created obstacle that serves no useful purpose, since the funds have already been approved by Congress and the president in previous appropriations bills. The debt limit doesn't prohibit new spending as much as it creates a situation in which the government cannot meet existing commitments and obligations. Prof. Wray shows how this situation arises by explaining how the federal government creates its funding through currency and securities issuance, and he puts forward a proposal showing how the process can be streamlined to resolve the dilemma.

"Here is the modest proposal. When Uncle Sam needs to spend and finds his cupboard bare, he can replenish his demand deposit at the Fed by issuing a nonmarketable, nonbond, nontreasury warrant to be held by the Fed as an asset. With the full faith and credit of Uncle Sam standing behind it, the warrant is a risk-free asset to balance the Fed's accounts. If desired, Congress can mandate a low, fixed interest rate to be earned by the Fed on its holdings of these warrants (to be deducted against the excess profits it normally turns over to the Treasury at the end of each year). In return, the Fed would credit the Treasury's deposit account to enable government to spend. When the Treasury spends, its account is debited, and the private bank that receives a deposit would have its reserves at the Fed credited.

"So, from the Fed's perspective it ends up with the Treasury's warrant as an asset and bank reserves as its liability. The Treasury is able to spend as authorized by Congress, and its deficit is matched by warrants issued to the Fed. Congress would mandate that these warrants would be excluded from debt limits since they are nothing but a record of one branch of government (the Fed) owning claims on another branch (the Treasury). The Fed's asset is matched by the Treasury's warrant—so they net out. (The same can be said about Social Security Trust Fund holdings of nonmarketable treasuries, which also should be excluded from debt ceilings—a topic for another day.)"

Sunday, March 27, 2011

"More fundamentally, the budget balance is equal to the difference between the government's receipts and outlays, but it is also equal, by definition, to the sum of private net saving (personal and corporate combined) plus the balance of payments deficit.

"If the private sector decides to save more, the government has no choice but to allow its budget deficit to rise unless it is prepared to sacrifice full employment; the same thing applies if uncorrected trends in foreign trade cause the balance of payments deficit to increase.

"A sensible target for the budget balance cannot be set unless it is integrated into a view about what will happen to autonomous trends and propensities in private net saving and foreign trade. Moreover, as those trends and propensities change, it will never be possible to determine viable targets for the deficit that are fixed through time such as, for instance, that it should never exceed some number such as 3 per cent of GDP or that it should on average be zero."

I’ve read that many of the most vicious fights in relationships have nothing to do with the immediate subject. Instead, deep-seated but unrecognized disagreements are often the real source of conflict: that row over how the bed was made was really about the fact that he’s unwilling to spend Christmas at her parents! I think there’s something similar going on with the current MMT/nonMMT debate in that there is a core inconsistency that not only places the two views on very different planes, but it is largely unspoken. It’s the elephant in the room.

That elephant is the full-employment assumption. It is such a mainstay of the various nonMMT views that it is second nature to them. In fact, even orthodox economists who lean towards interventionist policies believe the economy automatically seeks full employment. Take, for example, this statement by former Obama advisor, Christine Romer:

Just as there is no regularity in the timing of business cycles, there is no reason why cycles have to occur at all. The prevailing view among economists is that there is a level of economic activity, often referred to as full employment, at which the economy could stay forever.

By contrast, the Keynes/Post Keynesian view within which MMT exists argues specifically that the market system is prone to systematic breakdown and extended slumps brought on by insufficient demand. That the economy regularly languishes at less than maximum capacity is absolutely critical to a whole range of Post Keynesian analyses and recommendations. It is always in the back of our minds and represents the single most important driving force behind policy. Call this the IAD, or insufficient aggregate demand, position.

Now consider the debate as it emerges from these two largely-unstated positions with respect to the overall level of economic activity. For IAD+MMTers, it’s not simply that we are arguing that deficit spending is sustainable because it is financed in currency we are permitted to print. That makes it sound as if it’s just a matter of convenience. But, there is a much greater urgency to it. In the absence of government injections of income and wealth into the economy, we experience poverty in the midst of the capacity for plenty. The IAD view argues that government spending doesn’t crowd out private spending, it expands it. Deficit spending is necessary to the very success of capitalism because it represents the supplement to demand needed to take us to full employment. While the severity of this problem may vary over time, it never goes away. It is systemic, potentially offset via deficit spending (the specific form of which would be the subject of a different discussion).

But in the FEA vision, deficit spending is discretionary, largely unnecessary except for short-term fixes. After all, the economy is eventually going to correct itself, anyway. To some extent, demand management is merely a political expedient made necessary by the fact that unemployed workers are unwilling to wait for the natural processes to reassert themselves. And so, like money borrowed for a vacation abroad, deficits are a burden (and ultimately an unnecessary one).

It is my opinion that this is responsible for a critical underlying current in the debate between MMTers and nonMMTers. While on the surface we focus on the operation of modern financial systems and central banks, the split between FEA vs. IAD means that each side is placing this discussion into a radically different framework. And because this isn’t consciously recognized, we each feel exasperation over the fact that our opponents can’t see the obvious logic of our position.

I wonder if we should be making this more explicit? Obviously, the central argument is still with respect to the financing of government spending. And I don’t deny that MMTers do, in fact, make frequent mention of the need to bring the economy to full employment. What is less in evidence, however, is a conscious recognition of the fact that this (and not just the operation of the monetary system) is an absolutely critical point of departure. Because of IAD, we don’t see deficit spending as a quick fix. Rather, it is a permanent, and completely affordable, feature of a healthy capitalist economy. We can’t afford not to do it.

[For those more familiar with MMT than Post Keynesian economics, here is an explanation of the IAD position:

Paul Krugman wrote two blog aimed at "the modern monetary theory people" recently here and here. See my previous post here for comments. Since Prof. Krugman does not provide a citation, it is unclear to whom he is referring when he says "there’s a school of thought — the modern monetary theory people — who say that deficits never matter, as long as you have your own currency." Krugman italicizes "never," and it is key to his argument. But no professional MMT advocate has ever said "never." They are always careful to specify boundary conditions, that is, availability of real resources otherwise inflation will occur.

One hypothesis is that Prof. Krugman is referring to Dean Baker, who is not associated with MMT. Prof. Krugman recently wrote a column, "But couldn’t America still end up like Greece? Yes, of course. If investors decide that we’re a banana republic whose politicians can’t or won’t come to grips with long-term problems, they will indeed stop buying our debt. But that’s not a prospect that hinges, one way or another, on whether we punish ourselves with short-run spending cuts." Dean Baker, co-director of the Center for Economic and Policy Research, responded with a post, Krugman Is Wrong: The United States Could Not End Up Like Greece, attacking Krugman's position on this issue.

It is possible that Krugman was either responding to this post or to comments by MMT'ers regarding his column, but after scrolling through all 472 comments, I found no MMT'ers and no mention of MMT. So Baker is a strong possibility, unless Krugman just decided out of the blue to attack his erroneous conception of MMT. Maybe someone associated him with "those crazies" and he wanted to clear it up that of course he wasn't?

So the question is, was Prof. Krugman responding to Baker's criticism of his recent column, or was he purposely setting up a strawman to show that he is a Very Serious Person who is concerned about solvency and hyperinflation. Or is there something we don't know about?

By not citing a source, he leaves the question open. Hopefully, he will clear up this mystery and also set the record straight by admitting they he had no source for his statement, "there’s a school of thought — the modern monetary theory people — who say that deficits never matter, as long as you have your own currency." If so, he owes the modern monetary theory people an apology.

On another note, Warren Mosler responds to Dean Baker's criticism of Krugman here.

Gregory Mankiw, former chairmen of President George W. Bush's Council of Economic Advisors has engaged in a bit of debt fear mongering with a "what if" presidential address. So, I thought I would try my hand at a "what if" scenario involving the consequences of prolonged austerity.

The following is a presidential address to the nation-to be delivered in March 2026-

My fellow Americans, I come to you today with terrible sadness. Our country faces imminent collapse. The food and freshwater shortages which you are all familiar with have reached critical levels. The Protean Flu has overwhelmed medical facilities and the death toll continues to rise. The fundamentalist organization, the Christian Domination Brotherhood,has taken advantage of the chaos. A wave of bombings and assassinations targeting federal facilities and federal employees has crippled the government. These events are the direct consequence of choices made long ago. Now we are almost out of options.

For many years, the government has lived under the shackles of austerity. We promised ourselves long ago that we would not burden future generations with debt. So we cut. And froze spending. And levied punishing taxes (who can forget the hated and regressive Mankiw VAT of 2012). And thus condemned the future.

Our fresh water and food crises have followed from our forefathers' refusal to accept the science of anthropogenic climate change (if they could only see the Great Southwest drought or the food riots). This ignorance coupled with fear of debt made investment in agricultural research and development and water conservation/treatment infrastructure impossible.

The rise of the Christian Domination Brotherhood is directly connected to our past battles over Middle Eastern oil and refusal to address massive unemployment. Those of us who are old enough remember the oil wars that began in 2013. So many brave men and women were killed or permanently scarred by these horrific battles. To add insult to injury, they returned to a homeland wracked by economic recession. Jobs were not available for these former warriors and veteran medical services were reduced in the name of austerity. Many of these rejected veterans turned to religious zealotry and vowed revenge on the government that abandoned them. In the years since the oil wars, the hordes of the unemployed have only grown and consequently so have the numbers of the Brotherhood.

A different path could have been taken by previous generations. A path of full employment and planning for the future. Sadly, time's arrow only travels in one direction. So, tonight I am announcing that martial law is being declared. Recent intelligence reports suggest that the Brotherhood has acquired a number of nuclear devices and is planning to use them on vital points of the national infrastructure. This will not be allowed to happen. We will defend this country.

This is an example of the kind of pop-up ads I am getting from Google. This one features U.S. Congressional Rep. Michelle Bachmann of Tea Party fame, suggesting her supporters tell our elected officials to "stop spending cold turkey", by supporting a fixed limit on the amount of U.S. Treasury securities that can be issued.

The good news is that Krugman mentions Modern Monetary Theory by name on the #1 economics blog on the net, and it is a truism of public relations and marketing that all publicity is good publicity — and it is even better when it is unsolicited and free. Thank you for the shout out, Prof. Krugman.

For the wonks:

The crux of Krugman's hit piece is this: "I could go on, but you get the point: once we’re no longer in a liquidity trap, running large deficits without access to bond markets is a recipe for very high inflation, perhaps even hyperinflation. And no amount of talk about actual financial flows, about who buys what from whom, can make that point disappear: if you’re going to finance deficits by creating monetary base, someone has to be persuaded to hold the additional base."

Prof. Krugman presupposes "no IOR (interest on reserves)." But the Fed is already paying interest on reserves. Why suppose that if there are excess reserves that the Fed would not pay a support rate (IOR) consistent with the interest rate it targets (FFR), especially if no Treasury securities are draining the excess reserves?

As Anon points out in a comment at The Center of the Universe in this thread:

"IOR is not an option – its mandatory – if there are excess reserves and if the Fed runs a positive fed funds target – i.e. if the Fed wants to tighten at some point in the future. And he’s talking about excess reserves as a result of what he calls “monetizing” the deficit.

"That makes the difference between excess reserves and t-bills immaterial in terms of the interest rate and economic effect.

"He [Krugman] doesn’t seem to understand this.

"The failure to differentiate reserves and currency as distinct monetary components is quite foolish. That’s a trap that all economists who don’t understand the monetary system fall into."

CR: "Unfortunately, his argument is the logical equivalent of debating with someone about the potential decline in oxygen levels in the atmosphere and concluding with the absurd statement that “if the oxygen runs out tomorrow we will all die”. Of course this is true, but one must first explain what will lead to the lack of oxygen and the specific sequence of events. If you fail to do so you have failed to prove a point in the first place….Professor Krugman fails to connect the dots in a rational and logical sequence of events and it entirely discredits his conclusions."

BTW, I have tried to select a representative cross-section of the best comments and haven't included every relevant comment, so please don't be disappointed if yours doesn't appear. If Prof. Krugman reads only a few of these comments, I don't see how he can continue to hold his basically monetarist position.

"Decreasing the number and compensation of government workers. A smaller government workforce increases the available supply of educated, skilled workers for private firms, thus lowering labor costs [overall]."

The idea is clear. Decreasing government employment increases the number of educated and skilled jobseekers, thereby driving down wages for all workers by lower the offer. There being more bidders than jobs, the increased number of bidders competing with each other for limited offers will be inclined to accept a lower offer.

The GOP strategy is being played out in the states, where GOP governors are cutting taxes on business to make their states more attractive to businesses in order to lure businesses to the state. Cutting state government employment and reducing wages and benefits for existing workers lowers wages prevailing in the state, making the state more attractive to businesses. Reducing the power of unions and collective bargaining in their states also reduces the bargaining power of workers there. It is assumed that this will create more jobs in the private sector "by reducing labor cost." One wonders whether they have forgotten that workers are also voters who may not appreciate the lower pay scale and reduced benefits and protections.

The race to the bottom is on.

Where is the demand to come from, you ask? Ricardian equivalence, which Prof. Bill Mitchell dispatches at the link.

Here is what they say: "Keynesians hold that fiscal consolidation programs are contractionary in the short term, because they reduce aggregate demand. However, large government budget deficits create expectations for higher taxes to service government debt and affect the economy in the short term as well as the long term. Consequently, fiscal consolidation programs that reduce government spending decrease short-term uncertainty about taxes and diminish the specter of large tax increases in the future for both households and businesses. These “non-Keynesian” factors can boost GDP growth in the short term as well as the long term because:

• Households’ expectations of higher permanent disposable income create a wealth effect, which stimulates purchases of consumer durables and home buying thus driving up personal consumption expenditures and residential investment in the short term.

I will be on "Bulls & Bears" on Fox Business today at 4pm EDT. This is the new segment called, "Mike vs Charlie," where I will be debating Fox Business editor, Charlie Gasparino on topics related to economics, the markets and policy. This is going to be a regular Friday segment. Who knows...maybe if it's successful it will be turned into a show so be sure to watch!

Thursday, March 24, 2011

Tom posted a link to an article he came across from the late Jude Wanniski's Polyconomics which was a review of a paper written by Mundell and Laffer in 1975. I was a subscriber to Wanniski's analysis some years ago until his sudden passing.

It is titled "A New View of the World Economy", and provides what they believed was an operative description of the external sector in 1975. This was just a few years after the US completely abandoned the gold standard so perhaps at that time, people were very eager to come up with some new ideas as to what a new framework for understanding the global economy would be. Here is an interesting excerpt:

Going a step further, Mundell has revived the proposition, and Laffer has documented empirically, that money, like apples and gold, is also subject to these international forces of supply and demand. When, for example, there is an excess demand for money in the United States relative to the rest of the world, we will import money and run a balance of payments surplus -- i.e., more money will be coming into this country than is going out. When there is an excess supply of money in the United States, we will export money and run a balance of payments deficit. This idea also has its roots in earlier centuries, but is still a minority view among economists everywhere. Balance of payments deficits are thought to represent not a market phenomenon but a structural problem -- i.e., "capital flight" or "undercompetitiveness." Laffer has further demonstrated that when a country`s growth rate accelerates relative to the rest of the world its balance of trade worsens; and vice versa. (As a child grows, it consumes more than it produces.) But such a deficit is not cause for alarm. What is then happening is something perfectly natural. As long as its government does not speed up its own money creation, the country will export bonds to pay for its deficit in trade. All that is occurring is that the rest of the world has decided the country in question, with its higher growth rate, is a good place in which to invest. (Just as parents invest in their growing children).

Some observations:

The authors seem to treat all "money" as a singular fungible commodity, seemingly ignoring the fact that there are different currencies in every country; and the relative value of each (as indicated by an exchange rate) can change over time. Ignoring "Hickey's Law" ;) that a currency must stay in it's currency zone.

They state that a country with a higher growth rate will exhibit a balance of trade that "worsens", implying exports: good, imports: bad. This flies in the face of our current global situation where China has had MUCH higher growth than the US while at the same time running an external surplus with the US that is unprecedented in the entire history of human civilization.

Mundell and Laffer posit that a country can EXPORT bonds to "pay for" real imported goods; and that the country taking possession of a foreign country's bonds looks at such a transaction as an "investment".

These are bizarre descriptions of international transactions. This was written in 1975, just a few short years after the US dropped the gold standard in full so perhaps some understanding is in order as the authors may have been "brainstorming" to try to come up with a new framework.

But Wanniski's affirming review of these claims was written in 2005, and I am not led to believe that either Laffer or Mundell have significantly changed their perception of reality. Both Mundell and Laffer are still influential within economic policy circles. These beliefs may still influence policy recommendations they are making to this day.

Reading Central Banks Worldwide: Past, Present And An Uncertain Future gives the impression that the people in charge of the global financial system are clueless — and more concerned with their credibility than addressing their ignorance. This is doubly important because not only are central bankers in charge of managing a nation's finances, but also they are major players in determining the direction that the world economy takes in a century of increasing globalization.

TH: Right now central banking is the greatest threat to liberal democracy and national sovereignty. This is where global integration under a command system is emanating from.

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WM: i’d say the largest threat is from the failure to understand monetary operations

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TH: Warren, I agree on that economically. However, I am concerned about the political threat that cb independence and interdependence among cb’s constitute. I am sure that these people are well-meaning, and I agree that the direction is toward increasing globalism, but I don’t trust the direction they are taking to get there. If they understood monetary ops, that would be a help. but there is still [Dani] Rodrik’s trilemma to deal with, and I think they know this and have an agenda to force increasing integration at the expense of either national sovereignty or liberal democracy, since the three can’t all exist together. This is clear in the case of the EU/EZ, for example.

Rodrik's trilemma results from what he calls an "impossibility theorem."

DR: I have an "impossibility theorem" for the global economy that is like that. It says that democracy, national sovereignty and global economic integration are mutually incompatible: we can combine any two of the three, but never have all three simultaneously and in full.

What we are witnessing in the EU, through the EZ, is that the ECB is leading Europe toward greater economic integration. It was clear from the outset that this could only be accomplished by greater political integration that involves surrendering at least some national sovereignty. For example, joining the EMU involves surrendering monetary sovereignty by adopting the euro in place of national currency. The plan was to herd Europe toward greater politically integration gradually, by imposing greater economic integration with less national sovereignty and less democratic choice and control.

Initially, the goal of greater political integration was opposed democratically. What is happening in effect is that the leaders are trying to impose economically a political arrangement that failed at the polls and remains unpopular.

This attempt can be seen as a test case for greater integration of the world economy along the same lines. Should we as a nation be trusting our fate to clueless bankers who are also "interested men" in Tom Paine's sense of the phase? If they understood how the monetary system works, we might have a chance. But in is clear that they don't, or are hiding it very effectively for some unknown reason.

We need to be thinking carefully about Rodrik's trilemma and debating choices instead of letting ourselves be herded by small groups of technocrats that are unelected and unaccountable since they are "politically independent." Moreover, some of them are not even citizens of this country. At any rate, virtually none of them really know what they are doing from an MMT perspective of monetary operations. Should the clueless be in charge?

DISCLAIMER: The views put forward here have nothing to do with NWO conspiracy theories such as that being put forward here.

In my ongoing effort to make this blog the preeminent MMT and economics blog in the blogosphere I am pleased to annnounce another great coup! John Harvey will be contributing articles on a regular basis. Professor Harvey teaches economics at Texas Christian University with a specialty in post-Keynesian economics. He is also extremely knowledgeablein MMT and recently had an article published in Forbes.com entitled, "The Big Danger in Cutting the Deficit."

I want to personally welcome professor Harvey and I look forward to his contributions as I'm sure you all are as well.

Wednesday, March 23, 2011

We constantly hear about the debt left to our kids from government spending. It's $14 trillion, right? They pound this figure into our heads constantly. You can even go online and look up one of those crazy "debt clock" websites. They'll break it down for you as $45,818 per citizen.

So what is the debt? It's the amount of government securities--Treasuries--outstanding. "It's what WE owe," they say. Well is it what we owe or what the government owes? Let's be clear because it makes a difference. The debt is what the government owes. It owes it to the public, foreigners and to other government agencies.

From an accounting standpoint the debt is a liability of the government. However, to the non-government (that's us) it's not a liability, it's an asset.

Treasuries are nothing more than dollar denominated liabilities that pay interest and have some term or duration, say, 2 years, 5 years, 10 years, etc.

What's is a dollar bill, then?

A dollar bill is pretty much the exact, same, thing with only a couple of small differences. A dollar bill is a dollar denominated liability of the Federal Government, but it differs in that it has no term and pays no interest.

That's it. That's the whole difference between a dollar bill and a Treasury. No big deal.

Actually, you can think of a dollar bill as being like a checking account and you can think of a Treasury as being like a savings account or Certificate of Deposit. (Would you say you're broke if you held $14 trillion in a CDs?)

So by definition, those $14 trillion of Treasuries outstanding represent the same thing as if the government just handed out $14 trillion in cash, with a slight difference in duration and interest. And really, it's only about interest because you can roll over a Treasury as many times as you want making duration a moot point.

Ask yourself or your colleagues at work...if the government had sent out an enormous mountain of cash do you think people would be going around saying that it's some kind of great, big, liability that's going to be passed down to their kids and grand kids?

Hardly.

On the contrary, they'd be jumping for joy saying they've just inherited a windfall...a windfall that will eventually be handed over to future generations. They'd stop calling it a burden and instead, they'd be calling it a blessing.

Believe me, this is no lottery dream. It's exactly what's been going on. That $14 trillion "debt" is actually the exact same thing as $14 trillion of cash that has been literally handed out.

The crazy part is, in order for the government to "pay its debt" it would have to take back those trillions $$. And that's precisely what we are asking it to do. That's how we think we're going to "save" future generations. How dumb is that?

Portuguese lawmakers are voting against the planned imposition of new austerity measures. This is nothing short of a revolution as it will likely lead to the collapse of the existing government. The revolt against the highly destructive neoliberal economic agenda is spreading. Ireland will likely resist new austerity measures. We must bring this revolution right here to the U.S.A!

Beck has been mis-reporting the U.S. fiscal realities for some time, and is the 'poster child' for the misinformed, 'U.S. Treasury as a Household' analogy. This analogy is simply incorrect, and as Beck continues to propogate this analogy, he is actually doing more damage to the U.S. economy as the public is increasingly led to believe that our country has less fiscal options.

Here is a video from the impostor Beck (he is masquerading as an informed economist) where he is lamenting how "our banker" China can "take our assets".

He actually sounds deranged in this short segment. He sounds like he is starting to lose it by the end of the clip. (It's kind of funny!)

Glenn, please read here how China is not "our banker", and they have already been paid for their imports (in US dollars) and are simply placing their surplus US dollar denominated balances in ultra-safe US Treasury securities for the time being.

Mike, if he is trying to hold up Fox for more money, I suggest you tell Roger Ailes to just let him off the hook!

Tuesday, March 22, 2011

In Inequality and the Global Crisis, Branko Milanovic makes a case that the global financial crisis arose out of the hoard of savings at the top resulting from fiscal policy that reduced taxes at the top, rather than from the Ponzi finance now recognized as the proximate cause.

Milanovic observes:

The current financial crisis is generally blamed on feckless bankers, financial deregulation, crony capitalism and the like. While all of these elements may be true, this purely financial explanation of the crisis overlooks its fundamental reasons. They lie in the real sector, and more exactly in the distribution of income across individuals and social classes. Deregulation, by helping irresponsible behavior, just exacerbated the crisis; it did not create it.

To go to the origins of the crisis, one needs to go to rising income inequality within practically all countries in the world, and the United States in particular, over the last thirty years. In the United States, the top 1 percent of the population doubled its share in national income from around 8 percent in the mid-1970s to almost 16 percent in the early 2000s. That eerily replicated the situation that existed just prior to the crash of 1929, when the top 1 percent share reached its previous high watermark American income inequality over the last hundred years thus basically charted a gigantic U, going down from its 1929 peak all the way to the late 1970s, and then rising again for thirty years.

While the wealthy account for about 40% of consumption, there is a limit to how much the wealthy can consume. The rest is saved. Those who are sophisticated about money know that they cannot compound their savings through their own efforts as well as they can by hiring others to do for them. This generated a demand for above average returns from a bevy of financial professionals. Soon the better opportunities were identified and bid up, leaving a still large pot looking for spaces to occupy. The obvious solution for financial professionals was to "innovate" and create opportunities that did not yet exist.

One avenue would be to invest the funds in new ventures, but that is risky and good primary investments are limited. Clients were looking for regular performance that could be measured period over period. This meant generating credit instruments, such as securitization and other derivatives. This push to innovate in the financial sector lead to financialization.

Financialization exhausted normal channels, so financiers looked for new ways to expand credit. This led to extending credit to poorer and poorer risks as firms reached down into the pool of prospective borrowers. Competition resulted in a race to the bottom. As result credit quantity increased substantially, while credit quality decreased markedly.

Another problem was that real wages were not keeping up with productivity gains. The top was getting richer while the middle was stagnating and the bottom was losing ground, as welfare was cut. In MMT terms, demand leakage was not being offset by sufficiently large deficits, so either incomes had to increase or the economy had to contract, unless net exports increased, or the private sector increased indebtedness. What actually happened was that deficits were too low to offset the increase in net imports, which provided cheaper prices and tamed inflation, along with the increased saving taking place at the top. Worker incomes were held in check by neoliberal policy, e.g., weakening of labor and global labor arbitrage. Lax credit standards and competition for loans led to increasing private debt accumulating at the margin. The result is shown in the rising indebtedness at the middle and bottom that culminated at the cresting of the wave.

So "the first part of the equation" was the gathering of wealth at the top looking for a place to park at an attractive return, and "the second part of the equation" was the predicament of the middle and lower classes, who were not participating proportionately in economic growth. Moreover, they were becoming increasing indebted to maintain their standard of living, or even increasing lifestyle due to easy credit. Eventually, the level of private debt became unsustainable and finally imploded, drying up liquidity and plunging the world into a financial crisis from which it is still trying to recover as the middle class continues to deleverage.

Milanovic concludes:

The root cause of the crisis is not to be found in hedge funds and bankers who simply behaved with the greed to which they are accustomed (and for which economists used to praise them). The real cause of the crisis lies in huge inequalities in income distribution which generated much larger investable funds than could be profitably employed. The political problem of insufficient economic growth of the middle class was then “solved” by opening the floodgates of the cheap credit. And the opening of the credit floodgates, to placate the middle class, was needed because in a democratic system, an excessively unequal model of development cannot coexist with political stability.

Could it have worked out differently? Yes, without thirty years of rising inequality, and with the same overall national income, income of the middle class would have been greater. People with middling incomes have many more priority needs to satisfy before they become preoccupied with the best investment opportunities for their excess money. Thus, the structure of consumption would have been different: probably more money would have been spent on home-cooked meals than on restaurants, on near-home vacations than on exotic destinations, on kids’ clothes than on designer apparel. More equitable development would have removed the need for the politicians to look around in order to find palliatives with which to assuage the anger of the middle-class constituents. In other words, there would have been more equitable and stable development which would have spared the United States, and increasingly the world, an unnecessary crisis.

Sometime in early to mid April the United States government will run up against the limit of what it can legally borrow. The so-called “debt ceiling” will be hit and without an increase, the Federal government of the United States will not be able to pay its bills unless it resorts to drastic measures such as huge tax hikes and/or spending cuts. (More on that later.)

What is the debt ceiling?

The debt ceiling is a limit on what the government can borrow. It was created back in 1917, which was back in the time when we were still on the gold standard. Under a gold standard the quantity of money that the government could issue was essentially fixed. It depended on the amount of gold reserves we held because gold “backed” our money. If the government issued all the money it could under the gold constraint, but needed more, it would literally have to borrow. Congress created the debt ceiling as a way to limit government spending and borrowing.

In 1933, however, we went off the gold standard domestically and in 1971 Richard Nixon took us off of it for international payments as well. That meant gold no longer backed our money and the spending constraint was removed. Nowadays, when the government needs to spend it does so by merely crediting bank accounts. (Changing the numbers in your bank account.) Under this system the debt ceiling has really become an anachronism—a relic of a bygone age. So why do we still have to go through this dance every year or so?

Because of one little technicality.

To understand why the debt ceiling is still an issue you first have to understand how the government and the Treasury operate. The U.S. Treasury (the financial arm of the U.S. government) has an account at the Federal Reserve just like you have a checking account at your bank. Under rules that have been in place since the time when we were on a gold standard, the Treasury is precluded from running a negative balance in its account at the Fed. (The U.S. Treasury has no overdraft line of credit!!) This means when the Treasury’s checking account at the Fed gets drawn down to a certain level and cash needs arise, it must sell some bonds to raise the level of its cash balances. If it didn’t do this then technically, under the rules, it cannot continue to spend.

But is the U.S. government really limited in what it can spend?

Under the authority granted to it in the Constitution the government has monetary sovereignty and the power to issue currency. The Constitution places no limit on the spending power of the government, but it does require that the government make good on all its debts. Hypothetically, that means the government can spend whatever it wants, but because of this arcane and outdated rule, we have to go through this ridiculous debt ceiling dance every couple of years.

Can the U.S. default?

The United States has never defaulted on its debts and technically, it is not even possible because all of our debts are denominated in dollars and the United States government is the sovereign issuer of the dollar. However, there is a difference between the ability to pay your debts and the willingness to do so. Just because you have the money to pay doesn’t mean you are willing to pay. Any entity can default if they are not willing to pay what they owe.

To raise or not to raise…

This is the crux of the current debate that is raging along partisan lines in Congress. Some members believe that it is the duty of the U.S. to pay its bills and therefore, the debt ceiling should be raised without delay. Meanwhile, other members think that the spending has gone too far and the debt ceiling should be capped indefinitely even if it means putting the U.S. in default. So the prospect of default come mid April is very real given the current political and ideological environment.

It will likely go down to the wire.

If the debt ceiling is not is not raised we could still avoid a default, but Congress would have no other choice than to implement a series of very rapid and very large tax increases and spending cuts to close the gap. The Congressional Research Service estimates that the government will need an additional $732 billion above what it expects to receive in taxes and fees in order to cover expenses over the next six months. Spending and tax cuts of that size and in such rapidity would absolutely crater the economy.

Hopefully, cooler head will prevail and we will avoid the Doomsday scenario, but one thing looks certain: it will go down to the wire in a very huge and very scary game of brinksmanship.

This result suggests that current practice increases moral hazard and creates an incentive to undertake excess risk and misprice risk. It also disadvantages banks of lesser size and political clout that do not enjoy this benefit. It also presumes upon public finance in the expectation of preferential treatment owing to systemic risk, which creates a kind of aristocratic privilege. The authors summarize:

Accounting standards for recognising losses make it hard to detect if a bank is going under. The signs of a bank’s insolvency are slow to surface. During the housing and securitisation bubbles that preceded the 2007-2008 financial meltdown, top managers and regulators of US and EU financial institutions claimed that there was no way they could see the build-up of crisis pressures.

Moreover, as the crisis unfolded, these same officials failed to offer timely estimates of the financial and distributional costs of bailing out firms that benefited from open-bank assistance. The result is simple.

•The predictability of officials’ panicky willingness in crisis situations to acquiesce in these plans gives banking organisations that are difficult to fail and difficult to unwind what can be termed a “taxpayer put”.

Unless it is perfectly administered and adequately priced, this put supplies intangible capital to every firm that safety-net managers may be expected to protect.

Although these taxpayer puts do not trade directly, contingent-claims analysis offers several ways to estimate their value synthetically from the stock prices of individual systemically-risky firms.

While MMT shows that taxpayers do not fund bail-outs directly, as the authors suggest, since a monetarily sovereign government funds itself with currency issuance rather than taxation, MMT agrees that this does divert public funds from other uses for public purpose, and it constitutes a subsidy to a particular industry segment, owing to its ability to hold the government hostage because of its importance to the economy and political influence.

The authors reject the excuse of regulators that the situation with large banks was too complicated for them to be able to foresee insolvency problems. They conclude that transparency reduces the problem, and that capture, which they label corruption, accounts for ensuing government rescues. The authors conclude:

A useful first step would be to require bank managers to report data on earnings and net worth more frequently – under civil or even criminal penalties for fraud and negligent misrepresentation if they do not. Data on market capitalisation are publicly available in real time, as are data on stock-market returns. If the values of on-balance-sheet and off-balance-sheet positions were reported weekly or monthly to national authorities, rolling regression models could be used to estimate changes in the flow of safety-net benefits in ways that would allow regulators to observe and manage taxpayers’ stake in the safety net in a more timely and effective manner.

Fox has asked me to do a regular, Friday afternoon debate segment on Bulls & Bears. I will be squaring off against Charlie Gasparino. The format will be a kind of "point-counterpoint" thing.

Please send me ideas that I can propose for topics of discussion. It's an opportunity to get MMT out there. But remember, it has to be simple enough for mass consumption and very topical or related to something topical or Fox won't do it.

At its core, there are two parts to MMT. The first is a description of how the monetary system actually works, mostly focusing upon interactions between the central bank, the treasury, and the financial system, though this part also requires a very thorough understanding of the Minskyan-related literature of many MMT’ers (I note this because so many critics of MMT ignore or not aware of the vast MMT literature on financial instability and reforming the financial system). The second is a set of policy proposals that arise from this description and is largely outside the scope of this particular post but which can be found in any number of MMT publications and blogposts (and, again, including the sizeable MMT literature on reforming the financial system).

The Minskian aspect of MMT is often overlooked. However, it lies at the core of MMT macro analysis. Minsky was particularly concerned with the role of private debt and how changes in quantity and quality of debt affect the financial cycle. For example, financial instability rises as risk appetite grows and credit standards weaken to accomodate it. The financial cycle culminates in what Minsky described as Ponzi finance.

Ponzi finance is characterized by a situation in which cash flow is insufficient to service principal and interest without selling assets or borrowing. The housing crisis grew out of Ponzi finance, where buyers and lenders expected loans — mortgages and HELOCs — to be funded from future appreciation of the underlying asset, providing thin or no margin for error. In fact, the probability of error was magnified by lax standards. With no cushion, default was the only option for many, and foreclosures ballooned, while valuation tanked.

Dr. Housing Bubble has just posted an excellent analysis of this with respect to the bubble in residential real estate, as well as how it can be expected to work itself out.

This was entirely predictable based on the sectoral balance macro approach of MMT. The Clinton surpluses set up the debt dynamic by providing too little increase in nongovernment net financial assets to offset demand leakage, with the result that the private domestic sector was force into debt to maintain lifestyle. Creditors obliged with easy credit. The rest is history, which Dr. Housing Bubble summarizes from an insider's vantage. Dr. Housing Bubble lays this debacle directly on lenders, on one hand, and also on the wage dynamic over the past few decades, which has seen real wages either stagnant or falling.

The result of a credit implosion is the abrupt ending of the long financial cycle and an intermediate stage of market clearing before a new cycle can begin. The new cycle starts with much tighter credit standards. Dr. Housing Bubble sees US residential real estate in a clearing stage for the next year or two, with prices dropping further. He sees no return to appreciation in housing for some time after that, owing to the changed credit dynamic and stagnant incomes. Real wages have been declining for some time and are not likely to grow soon, given the current trajectory and climate.

Moreover, growth is occurring in the rental market while home ownership is declining. People are now looking at home ownership in a different light, no longer under the spell that housing values always rise, so that home ownership is the optimal middle class investment. The growth in building permits is now in multi-dwelling units in anticipation of an increase in renters.